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This Will Change the Way You Invest

Free commissions may increase ETF use exponentially.

Exchange-traded funds have become one of the most popular investment vehicles during their relatively brief history. Now, though, one major discount broker is preparing to offer ETFs in a way that few have seen before: free of charge.

More new ETFs? YawnCharles Schwab(NASDAQ:SCHW) recently announced that its investment management arm would introduce eight new ETFs. That by itself is nothing special. All sorts of money management companies -- from ETF industry giants like Barclays(NYSE:BCS) Global Investors and State Street(NYSE:STT) Global Advisors, to newcomers like bond-guru company Pimco -- have given investors a steady stream of new ETFs to choose from.

In addition, Schwab's ETFs don't exactly add much to the universe of investments already available. The four ETFs that started trading yesterday include a large-cap fund, a small-cap fund, a broad-market fund that includes both large-cap and small-cap stocks, and an international fund. Here's a quick rundown of the new ETFs:

Fund

Expense Ratio

Top Holdings Include

Schwab US Broad Market ETF

0.08%

ExxonMobil(NYSE:XOM)

Schwab US Large-Cap ETF

0.08%

ExxonMobil

Schwab US Small-Cap ETF

0.15%

Human Genome Sciences(NASDAQ:HGSI), Aeropostale

Schwab International Equity ETF

0.15%

HSBC(NYSE:HBC), BP(NYSE:BP)

Source: Schwab.

In addition to these four, Schwab intends to introduce ETFs that cover other asset classes, including international small-cap stocks and shares of emerging-market companies, as well as different funds focusing on value stocks and growth stocks.

The biggest discount possibleWhat sets the Schwab offerings apart, is that you can buy or sell them without a commission if you're a Schwab customer. That saves you up to $12.95 per transaction compared with what you'd pay at Schwab for other ETF trades.

The commission savings is the most important element of the new ETF offering, but it's not the only one. The ETFs also offer extremely low expense ratios that compete quite favorably with offerings from industry leaders. This combination of low-cost features makes it clear that Schwab is aiming at cost-conscious investors who want the flexibility that ETF investing offers.

Opening up a whole new worldThe reason Schwab's move is so ingenious is that it makes ETFs accessible to a whole new audience of investors with small and mid-sized accounts. Although ETF investing is useful for those with large sums of money to invest at a time, ETFs traditionally haven't been as useful for those who regularly add a little bit of money at a time. For instance, if you have only $200 to invest every month, then paying $12.95 in commission is a huge chunk out of your investment.

Now Schwab investors can add small amounts to their ETF holdings on a regular basis without worrying about the transaction costs. That will let them build an ETF-based regular investing program that encourages saving.

It's true that customers at Schwab and elsewhere can do much the same thing with traditional mutual funds. Yet ETFs carry some advantages over mutual funds, including greater tax efficiency than some regular mutual funds as well as the ability to trade anytime the market is open. In addition, trading with ETFs gets customers used to the broker's trading interface, which will make customers more comfortable considering commission-generating trades of stock and other investments.

Worth jumping?Schwab's decision to offer ETFs free of charge is a gutsy move that makes a lot of sense. Although some smaller, lesser-known brokers already offer no-commission trades, Schwab is making a tactical decision that will help retain current clients and attract new ones without jeopardizing its overall revenue generation.

Moreover, it's extremely tough for new ETFs to muscle in on existing funds, especially with broad-market funds like these. But Schwab's strong client base will have a huge incentive to use these ETFs rather than competing funds. If Schwab's gambit works, then I'd expect to see other companies, such as Vanguard and Fidelity, follow suit and leverage their own customer followings.

In the meantime, no-cost ETFs may not by themselves be enough reason to open a brokerage account, but it certainly can't hurt. Anything that brings costs down for regular investors is a step in the right direction.

Change the way you invest today by finding the discount broker that's right for you. We can help with this handy broker comparison tool -- check it out today.

Fool contributor Dan Caplinger has always liked mutual funds, but this news has him pondering a major switch. He doesn't own shares of the companies mentioned in this article.Charles Schwab is aMotley Fool Stock Advisorrecommendation. Try any of our Foolish newsletters today, free for 30 days.The Fool's disclosure policy knows that if it ain't broke, you shouldn't fix it.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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